Technology, R&D, and Efficiency

Chapter 13W

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13W-2

Invention, Innovation, and Diffusion

• New and better products• Better ways of producing and distributing

those products• Occurs over the very long run• Profit is the incentive

LO1

13W-3

Invention, Innovation, and Diffusion

• Short run• No change in technology, plant, or

equipment• Long run• No change in technology

• Very long run• Technology changes with R&D

LO1

13W-4

Invention, Innovation, and Diffusion

• Invention• New product or process• Based on scientific knowledge• Patent protection

• Innovation• Product innovation• Process innovation• Can’t be patented

LO1

13W-5

Invention, Innovation, and Diffusion

• Diffusion• Spread of innovation through imitation or

copying• Firms embed new innovation• Crucial to capitalism

• Requires R&D expenditures

LO1

13W-6

Global Perspective

LO1

13W-7

Appliedresearch(invention) 15%

R&D Expenditures

LO1

Development(innovation andimitation) 80%

Basicresearch

5%

13W-8

Modern View of Technological Advance

• Technological advance• Capitalism is the driving force• Profit is the incentive• Rivalry among firms is the cause• Starts from within the economy• Internal to capitalism

• Old view was a random event from outside the economy

LO1

13W-9

Role of Entrepreneurs

• Initiator, innovator, and risk bearer• Forming start-ups• Other innovators• Innovating within existing firms• Anticipating the future• Exploiting university and government

scientific research

LO2

13W-10

A Firm’s Optimal Amount of R&D

• Marginal benefit and marginal cost• Interest-rate cost-of-funds• Bank loans• Bonds• Retained earnings• Venture capital• Personal savings

• Interest-rate cost-of-funds curveLO3

13W-11

20

16

12

8

4

0 20 40 60 80 100

Inte

rest

rat

e, i

(per

cent

)

R&D expenditures (millions of dollars)

i

Interest-rate cost-of-funds curve

R&DMillions

$10

20

30

40

50

60

70

80

Interest-Rate Cost of

Funds, %

8

8

8

8

8

8

8

8

LO3

A Firm’s Optimal Amount of R&D

LO3

13W-12

A Firm’s Optimal Amount of R&D

• Expected rate of return “r”• Marginal benefit from R&D

• Expected-rate-of-return curve• Slopes downward due to diminishing

returns for R&D expenditures• Expected not guaranteed returns• Adjustments• Optimal amount of R&D

LO3

13W-13

A Firm’s Optimal Amount of R&D

20

16

12

8

4

0 20 40 60 80 100

Expe

cted

rat

e of

ret

urn,

r (p

erce

nt)

r

Expected-rate-of-return curve

R&DMillions

$10

20

30

40

50

60

70

80

ExpectedRate of

Return, %

18

16

14

12

10

8

6

4

R&D expenditures (millions of dollars)LO3

13W-14

A Firm’s Optimal Amount of R&D

20

16

12

8

4

0 20 40 60 80 100

R&D expenditures (millions of dollars)

ExpectedRate of

Return, %R&D

Millions

InterestRate

Cost offunds, %

18

16

14

12

10

8

6

4

$10

20

30

40

50

60

70

80

8

8

8

8

8

8

8

Expe

cted

rat

e of

ret

urn,

r, a

nd In

tere

st

rate

, i (p

erce

nt) r = i

LO3

13W-15

Increased Profit via Innovation

• Increased revenue via product innovation• Importance of price• Unsuccessful new products• Product improvements

• Reduced cost through product innovation

LO4

13W-16

Increased Profit via Innovation

Unit of Product

Marginal Utility,

Utils

Marginal Utility per

Dollar(MU/Price)

Marginal Utility, Utils

Marginal Utility per Dollar, MU/Price)

Marginal Utility, Utils

Marginal Utility per Dollar, MU/Price)

First 10 10/1=10 24 24/2=12 52 52/4=13

Second 8 8/1=8 20 20/2=10 48 48/4=12

Third 7 7/1=7 18 18/2=9 44 44/4=11

Fourth 6 6/1=6 16 16/2=8 36 36/4=9

Fifth 5 5/1=5 12 12/2=6 32 32/4=8

With $10 and choice of A and B(2A, 4B)

With $10 and choice of A, B or C (1B, 2C)

13W-17

Increased Profit via InnovationTo

tal p

rodu

ct

Ave

rage

tot

al c

ost

Units of labor Units of output

2500

2000

1000

TP1

TP2

ATC1

ATC2

2000 2500

$5

0

4

0

Upward shift of thetotal product curve

Downward shift of the average total cost curve

LO4

13W-18

Imitation and R&D Incentives

• Imitation problem• Fast-second strategy• Benefits of being first• Patents, copyrights, and trademarks• Brand-name recognition• Trade secrets and learning by doing• Time lags• Profitable buyouts

LO5

13W-19

Global Perspective

LO5

13W-20

Imitation and R&D Incentives

LO5

13W-21

Role of Market Structure

• Pure competition• Incentive to innovate, but rate of return is

low• Monopolistic competition• Incentive to differentiate but profits are

temporary

LO6

13W-22

Role of Market Structure

• Oligopoly• Large size• Ability to finance R&D• Barriers to entry can foster R&D• Complacency is a negative

• Pure monopoly• Little incentive to innovate due to strong

barriers to entry protecting profits

LO6

13W-23

Inverted U Theory of R&D

• Inverted U Theory of R&D• Firms’ R&D spending rises with the industry

concentration ratio• Reaches a peak at 50%• Declines after 50%• Empirical evidence generally supports this

theory

LO6

13W-24

Inverted U Theory of R&DR&

D e

xpen

ditu

re a

s a

perc

enta

ge o

f sal

es

Concentration ratio (percent)

More competition Less competition

0 25 50 75 100

LO6

13W-25

Technological Advance and Efficiency

• Productive efficiency• Increasing productivity of inputs

• Allocative efficiency• A more-preferred mix of goods and services

• Creative destruction

LO7

13W-26

Decline in Federal R&D Spending

• Government spends on basic scientific research

• Benefits not realized for many years• Private business prefers R&D that can be

profitable quicker• Federal spending on basic scientific research

measured as a % of the budget has declined • Now consumption spending by government is

favored over investments in scientific research